The new cabinet is settling in. But what does this Labour win mean for your wallet? MoneyWeek takes a look
Gordon Brown is considered by many to be a very lucky man. When he took over the running of the UK economy, it was in pretty good shape: interest rates and inflation were falling (thanks partly to sensible policy and partly to the low-inflation environment around the world) and unemployment was on the way down. Labour’s election claim was that things could only get better, and they were right. It’s just that, given that all the ingredients were in place for things to get better already, it wouldn’t have mattered who was in power: things were getting better anyway. Unemployment was following suit. As Ruth Lea pointed out in The Daily Telegraph, Gordon Brown “was extremely fortunate to inherit an economy in such fine shape”. It was “a golden legacy”.
It was also one that he took reasonable care of for a while. Brown and Tony Blair stuck, as promised, to the previous Conservative government’s spending plans for all of their first term, for example. But then, with their second win in 2001, things started to change. Spending rose, the tax take rose dramatically and red tape began to wind its way around British business again. Over the last few years, says Lea, “higher taxes, a bloated public sector and burdensome regulations have progressively chipped away at our competitiveness”.
Third terms are often tough going, says Larry Elliott in The Guardian: “think Macmillan after 1959 and Thatcher after 1987.” Not only do governments get cut less slack in later terms (they just don’t get the benefit of the doubt anymore), but there seems to be an added chance of “catastrophic policy mistakes” (the Lawson boom, the poll tax and the ERM entry all occurred in Thatcher’s third term). Unfortunately for Brown, however, it is beginning to look as though he won’t need to make any more mistakes in this term for things to go horribly wrong. He’s made quite enough already: just as all the ingredients were in place for a strong economy in 1997, they are all now in place for a weak economy.
The way we live now
The Brown and Blair double act has just won an election based, to a large degree, on their insistence that Labour is good for the economy. (“New Labour is the party of modern wealth creation and prosperity,” said Tony Blair in a pre-election speech.) During the campaign, the press didn’t dispute this with any great enthusiasm. But now it is over, it appears to be a different story: a rash of unexpectedly bad statistics appears to be bringing home some nasty truths: interest rates have gone up a third in the last two years; personal debt is at a record high; personal bankruptcies are hitting new records; figures out on Tuesday showed the worst decline in manufacturing for three years (output declined by 1.6% in March); retail-sales growth is at its worst for 13 years; house prices are starting to fall; repossession orders are up more than 35% on last year; inflation is rising fast, as is the tax take as a percentage of gross domestic product (GDP); and finally, the Government is deeply in debt. In 2000/ 2001 there was a budget surplus worth 1.6% of GDP. Now there is a budget deficit worth 2.9% of GDP. It doesn’t look good, says Elliott: “the economy may have been boring in Labour’s first two terms, but it ain’t going to stay that way”. Things can only get worse, agrees The Economist. Low interest rates and high public spending may have made things look good over the last few years, but scratch the surface and nothing looks good: “the Government has been storing up trouble for the future”.
Where we go next
So what happens next? There is a growing body of opinion that suggests the UK could be heading for a serious soft patch, at best, or a recession at worst. Here we look at some of the factors that could push things over the edge.
Interest rates and inflation: During the election campaign, New Labour claimed that mortgage rates were at their lowest for 40 years. This sounded good, but it wasn’t strictly true: interest rates have risen a good 30% in the last two years, so mortgage rates were a lot lower two years ago than they were last week.They may have moved up from low levels, but it is still a massive leap for the heavily indebted. So will interest rates move higher still? The consensus shifts dramatically on this one every few weeks. Before the election, everyone thought they would rise, but now the dreadful retail numbers are sinking in, many think they should fall. We’re not convinced. The fact is that inflationary pressures have been exerting themselves on the British economy for a number of years.In March, the consumer price index hit 1.9% and the Bank of England itself predicts it will break through the Government’s target level of 2% later this year. The retail price index is running at 3.2%, as are factory output prices. At the same time, wage inflation is running at 4.4% as private-sector workers demand a bigger slice of the corporate profits made over the last few years and public-sector workers demand more too. Not all of the inflation in the system is specific to the UK (commodity prices are rising all over the world), but the fact remains that it is there, and if it keeps rising, rates will have to rise too.
Houses and retail sales: Rising interest rates won’t help an already suffering housing market. Low rates have driven the boom of the last few years, but they have also left much of Britain, and buy-to-let investors in particular, over-leveraged and very vulnerable both to rising rates and falling house prices. So will house prices crash? Very possibly. According to Nationwide, house prices fell 0.6% in March, it is taking 26% longer to sell a house than a year ago, and twice as many homes are now on the market. Oh, and repossessions are up to their highest level in a decade. It’s already bad, but there is still plenty of worse news to come. “We expect house prices to fall by 10% by the end of 2006. Mortgage approvals are currently down 35% year-on-year and it is only a matter of time before this decrease in demand feeds through to lower prices,” says James Carrick, UK economist at ABN Amro, in a report out last week called “Divine Comedy”.
That’s not good for retailers. The feelgood factor has already disappeared from the high street and retailers of all descriptions are suffering. As China increases its wages – and possibly revalues its currency – and oil and commodity prices stay high, retail costs are soaring. Yet the costs cannot be passed onto consumers: thanks to their high levels of debt, it’s hard to make them spend at all, let alone accept much in the way of rising prices.
Jobs: And what do tighter margins and falling sales mean? That capacity needs to be cut. According to ABN Amro, 5% of Britain’s retail capacity needs to go, something that means 150,000 jobs are in danger. And that’s not the half of it. The bank also predicts large-scale job losses in manufacturing (thanks to rising input prices and falling output) and construction (thanks to the collapse of the housing market). Those job losses will depress consumer spending further, fuelling more job losses, until by 2008, a little over half way through Labour’s third term, half a million more people will have joined the dole queue. The result? The UK economy “islikely to remain depressed for several years, largely driven by high household debt and a sustained rise in unemployment rates”. For some time now, public-sector employment has been rising at an astonishing speed – over the last three months of 2004, 298 people a day have been added to the taxpayers’ payroll. But this can’t go on for ever. Even Gordon Brown can’t employ everyone. “The true story of the jobs market will, therefore, become apparent over the coming years. The chances are that it will not be a happy one,” says Edmund Conway in the Daily Mail.
Pensions: Blair and Brown managed to shift the issue of the black hole in the UK’s pension system out of the limelight for the duration of the election campaign by promising reforms once Adair Turner’s final report is finished in the autumn, but it isn’t going to go away. The first issue is private pensions. Many schemes are either in serious trouble, or at the very least underfunded, and very few of us are saving sufficient amounts to fund our retirement. Then there are public-sector pensions. Public-sector employees tend to receive relatively generous final salary pension schemes, so the recent rise in the number of those employees means that the (hefty) bill for them will have to be met by the taxpayer. Neither central Government nor local authorities have budgeted for this, so the money just isn’t there.
Taxation: Still, as is always the case, the money is going to have to come from somewhere, and usually that somewhere is tax. Tax as a percentage of national income usually hovers between 33% and 37%, says Brian Durrant on Daily reckoning.co.uk. Today, the Chancellor’s projections point to a tax take of 40.5% by 2008. Labour has introduced 66 stealth taxes since 1997, and thanks to the static levels of the tax bands, another 160,000 people will pay top-rate tax this year – bringing the total to 3.56 million people, up from just two million in 1997. But that still isn’t going to be enough. Public spending has increased by 59% in the last five years, with more expenditure planned, and Brown is proposing to cover all his spending plans – and deal with the black hole – simply from growth: he forecasts GDP growth of 3%-3.5% this year and hopes that that will bump up the tax take enough to cover everything. Unfortunately, with growth figures being revised down by analysts everywhere, the odds of that strategy working are looking remote. It looks like “the consensus behind higher taxes… will have to be reforged, perhaps at a time when the economy is sluggish and voters are facing a squeeze on their real incomes”, says Larry Elliott in The Guardian. Prepare for your taxes to rise.
The tax rises you should expect under Labour
Economists aren’t known for their unanimity, says Hamish McRae in The Independent, but one thing almost all of them seem to agree on is the fact that taxes will have to go up during Labour’s third term in office. The International Monetary Fund thinks so; the Institute for Fiscal Studies thinks so. Even the Treasury thinks so, although, unlike everyone else, it believes tax revenues can rise without there being significant increases in tax rates, as the percentage of the population caught in the income-tax net continues to rise because Brown failed to raise tax allowances in line with rising pay rates. Revenue and Customs estimates show that in the next tax year, 30.5 million will be liable for income tax; in the Tories’ final year in office, 25.7 million people were liable.
The Institute for Fiscal Studies is less optimistic than the Treasury. It predicts the average family faces tax rises averaging £1,000 a year, equivalent to a tax increase of around 3p in the pound. And, says McRae, “if you want big money you have to go for big taxes”: picking up the odd billion by thinking up some “new wheeze” such as the tax on airfares won’t do the job. Since Labour has pledged no rise in basic or top rates of tax, that really only leaves corporation tax and national insurance. Both present big problems. Rises in corporation tax may force companies to relocate, while raising national insurance, particularly in “the cooler climate of the next couple of years”, could score “a catastrophic own goal” as the private sector is forced to cut employment.
There are more tangible and certain ways in which your pocket will be hit by the recent Labour victory – some of them good, and some of them bad. Council-tax rises this coming year are expected to be ‘just’ 4%, after two years of big increases, and in 2007 properties will be revalued. Over-65s are to receive a one-off payment of £200 this year towards the cost of council-tax bills, and over-60s will be eligible for free off-peak bus travel. The pension credit, currently £109 per week, is to increase in line with average earnings up to, and including, 2008. Major reform is expected on pensions after Adair Turner’s independent Pensions Commission reports in October this year.
Turner is likely to propose some pretty tough choices, says The Independent on Sunday: a higher statutory retirement age, higher tax, or better incentives to save through a private pension.VAT will not be extended to food, children’s clothes, books, newspapers and public-transport fares, and the pre-election budget doubled the threshold for paying stamp duty on property purchases to £120,000. Individual Savings Account (Isa) limits, which allow you to save up to £7,000 tax-free, were recently confirmed until 2010. Brown pledged to increase the inheritance-tax threshold from £260,000 to £300,000 by 2010The minimum wage is to rise to £5.35 this October. University tuition fees will be capped at no more than £3,000 a year, with maintenance grants restored for the poorest students. Subject to consultation, paid maternity leave is to be extended from six months to nine months in 2007. Parents of three and four-year-olds will be entitled to 15 hours of free nursery care a week during term-time by 2010, and children up to 14 are to be offered out-of-hours care at school from 8am to 6pm. Families earning up to £59,000 a year will be able to get means-tested help with the cost of a nanny or au pair.
Motoring costs are due to rise. Motorists currently pay £42bn a year in taxes, including fuel duty, car tax and VAT on vehicles and fuel, as well as more than £100m a year in speed-camera fines, says John Thornton in the Daily Express. Meanwhile, congestion is thought to cost the economy up to £20bn a year, mainly in lost productivity. To combat this, transport secretary Alistair Darling is proposing a national system of road pricing that could see charges rise to as much a £1.34 per mile on the busiest roads.To implement the system, car movements will be monitored at all times by spy-in-the-sky satellites. Drivers of gas-guzzlers face an increase in road tax